Assessing Debt Sustainability in Emerging Market Economies Using Stochastic Simulation Methods

34 Pages Posted: 25 Jan 2006

See all articles by Doug Hostland

Doug Hostland

Government of Canada

Philippe D. Karam

International Monetary Fund (IMF)

Multiple version iconThere are 2 versions of this paper

Date Written: January 2006

Abstract

The authors apply stochastic simulation methods to assess debt sustainability in emerging market economies and provide probability measures for projections of the external and public debt burden over the medium term. The vulnerability of public debt to adverse shocks is determined by a number of interrelated factors, including the volatility of output, financial fragility, the endogenous response of the risk premium, and sudden stops in private capital flows. The vulnerability of external debt is sensitive to the determination of the exchange rate and to the pricing of traded goods. The authors show that fiscal policy can act in a preemptive manner to prevent the debt burden from rising significantly over the medium term. This requires flexibility in fiscal planning, which many emerging market economies lack. Emerging market economies therefore face a difficult tradeoff between managing the risk of a debt crisis and pursuing other important fiscal policy objectives.

Keywords: Debt sustainability, fiscal sustainability, fiscal & monetary policy

JEL Classification: C15, H62, H63

Suggested Citation

Hostland, Doug and Karam, Philippe, Assessing Debt Sustainability in Emerging Market Economies Using Stochastic Simulation Methods (January 2006). World Bank Policy Research Working Paper No. 3821, Available at SSRN: https://ssrn.com/abstract=877311

Doug Hostland (Contact Author)

Government of Canada ( email )

Esplanade Laurier, 18th floor, East Tower
Ottawa K1A 0G5, Ontario K1A 0G5
Canada

Philippe Karam

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

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